Emergency Fund Investment Options

April 25, 2007

Yesterday we heard from Golbguru and Silicon Valley Blogger about different factors that determine how much is enough money to keep in your emergency fund. Today Sun looks at a combination of three different options that we have for keeping our emergency fund liquid but also earning a return on our money while it sits waiting for an emergency.

Sun @ The Sun’s Financial Diary
The purpose of establishing an emergency fund is to have some money in place that is enough to cover your daily expenses when your income stops, such as lose your job. The appropriate amount of an emergency fund really depends on you spend every month on average. Multiplying the average monthly spending by the time (in months) that it will take you to find a new job will be the amount that you should set aside as en emergency fund.

There are suggestions that the emergency fund should be enough to maintain your normal life for six months, but at least 3-month worth of fund is necessary. Since the emergency fund is only supposed to be used in case of an emergency, it’s possible that one may be over-prepared by putting too much into an emergency fund. In my opinion, you don’t need a 12+-month cushion.

Money in the emergency fund should be easily accessible, meaning that you can’t use the money to make a long-term commitment such as investing in stocks or buying a long-term CD and you don’t want to put it a brick-and-mortar bank’s checking account which earns you close to nothing either. Several years ago your neighborhood bank might be your only choice, but not now. Here’s what I do with our emergency money.

1. Checking Account
I put several thousands in my local bank’s checking account so I can withdraw the money right away without any delay. If all the sudden I have a big bill to pay, in most cases I can pay it with credit cards, so I don’t have to keep a large amount of cash in my checking account. The rest of the money goes to the following:

3. 4-week T-bills
This is my favorite for short-term investment that generate decent returns. Currently 4-week T-bill pays 4.939% APR, which is equivalent to 5.05% annual yield. However, since interests from T-bill investments are exempted from state and local income taxes, your actually yield will be higher (here’s a formula to calculate your equivalent yield).

From what I can see, there two drawbacks of investing in T-bill. First, T-bill rates change every week, so you don’t know in advance what you will get for your next investment (a couple of weeks ago you could earn 5.36% APY). Second, you money will be tied up for four weeks, but that’s a small price to pay for a better return, in my opinion.

Emergency Fund Overview
Check back tomorrow when we’ll summarize the input from fellow personal finance bloggers and readers on how much to have in your emergency fund and where to keep your money.

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Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.